Investing in a Fiscal Dominant World: High Debt to GDP

We are entering a new era of investing where the previous advice and strategies will no longer apply.

The Boglehead portfolio, 60/40, and other simple investment strategies may not be applicable in the future.

Why the 125% US Debt to GDP Ratio Changes the Rules

The US Debt to GDP ratio is around 125%. Debt is growing faster than the economy. Also, the US government continues to spend more than it collects in taxes.

It’s issuing this new debt on the short end of the curve (T-bills) because who is going to want to purchase long term bonds that will lose in real terms over the next 20-30 years?

The debt problem has trapped the Federal Reserve. If more debt is being issued in T-bills, the Fed is going to have to cut interest rates even more. Lowering interest rates makes the debt payments more manageable. The US government won’t have to borrow as much to pay the interest on the debt.

The problem is that when inflation heats up, the Federal Reserve won’t be able to hike rates. If they increase rates to fight inflation, the interest rate on the national debt increases as well. This means the government will have to borrow even more to pay its interest payments.

This is also the first time in history that the world’s reserve currency (US dollar) is a fiat currency (not backed by anything), and national debt is greater than GDP.

But US Debt to GDP Was This High During World War II!

Others will point out that Debt to GDP was this high during World War II and we can grow our way out of it. It’s true that Debt to GDP levels are similar, but there are major differences between then and now.

First, is that after World War II the US Dollar was pegged to the price of gold. This was called the gold standard. 

Today, the USD is backed by nothing. We live in a completely different monetary system.

Second, the US was in a unique position after World War II because the rest of the world was destroyed. The US was able to grow its way out of debt because it was the only major country whose mainland was unharmed. 

Today, there is global competition for manufacturing and production. 

My Fiscal Dominance Investment Thesis

With these things in mind, it’s important to look at the situation the US is in and think about how to invest and even potentially take advantage of the debt issue.

US Debt to GDP will continue to increase.

The government will be forced to adopt fiscal dominance policies to prevent the financial system from blowing up.

Therefore, investing strategies should change to account for fiscal dominance.

I created five investment categories to help myself understand how the US debt problem will influence the future of investing. This isn’t investment advice, rather a glimpse into how I view investing in this new high Debt to GDP world.

The Five Pillars for Investing in a Fiscal Dominant World

Productivity Premium: AI, Tech, and Deflationary Growth

Productivity premium stocks and ETFs are currently the major tech companies. These companies include the Magnificent Seven and other companies that are involved in AI, cloud computing, and data collection and processing.

These companies offer real productivity benefits where the economy becomes more efficient. This means things like tasks are completed faster or less resources are needed to complete a task.

We have seen productivity premium stocks and ETFs outperform the broader market for the past five years.

The Magnificent Seven, tech ETFs, semiconductor ETFs, and growth ETFs have had returns greater than the broader market AND gold (which I use as a measure of monetary debasement).

Currently, Productivity Premium companies can be classified into three different categories: Business to Business (B2B), Hybrid, and Business to Consumer (B2C). Productivity Premium companies can move in between the sub categories depending on their business plans and products they offer. This is what it currently looks like.

Business to Business (B2B): AI Hardware and Chips

Here’s how current Business to Business companies can be broken down.

• Hardware & Chips: These companies are focused on the AI revolution. They build infrastructure that allows the rest of the economy to automate and become more efficient.
  • Nvidia (NVDA), Broadcom (AVGO), Arista Networks (ANET), Amphenol (APH), KLA Corp (KLAC), Applied Materials (AMAT), Lam Research (LRCX), Analog Devices (ADI), Texas Instruments (TXN), Qualcomm (QCOM), and Micron (MU).
• Software: These companies sell “deflation as a service”. Companies use this software to do the work of multiple people.
  • Microsoft (MSFT), ServiceNow (NOW), Oracle (ORCL), CrowdStrike (CRWD), Palo Alto Network (PANW), Intuit (INTU), Adobe (ADBE), Salesforce (CRM), IBM (IBM), and Cisco (CSCO).
• Science & Biology: Companies that make healthcare faster and cheaper.
  • Intuitive Surgical (ISRG), Danaher (DHR), Stryker (SYK), and Vertex Pharamceuticals (VRTX).

Hybrid: Consumer Reach with B2B Moat

Hybrid Productivity Premium companies have a massive consumer reach, but they make massive profits through B2B sales.

Their B2C sales can almost be viewed as a utility. People pay monthly fees for memberships to Google Cloud and Amazon Prime.

• Amazon (AMZN)
  • B2B: AWS cloud services.
  • B2C: Amazon Prime memberships and people purchasing goods online.
• Google (GOOG)
  • B2B: Google Cloud and AI.
  • B2C: Advertising and Google Pixel.

Business to Consumer (B2C): Consumer Tech Giants

These companies offer potential productivity bonuses, but they also have exposure to the real economy. If the average person loses their job or has to cut costs, these companies could be more affected than B2B companies.

Here are some examples of B2C Productivity Premium companies:

• Apple (AAPL)
  • Most of Apple’s revenue comes from iPhone sales. However, they are expanding into services like subscriptions, so they might become a Hybrid later on.
• Meta (META)
  • Meta makes almost all its money from advertising. This is sensitive to how well the consumer is doing.
• Tesla (TSLA)
  • The majority of revenue is from automotive sales. If people can’t afford to buy a new Tesla, then the company suffers.

Productivity Premium Risks: Is there an AI Bubble?

There are several major uncertainties in productivity premium companies.

I don’t know how many articles I’ve seen that have mentioned the “AI bubble” lately.

I have no clue if we are in a tech bubble or AI bubble, but the reason people keep investing in these companies is because they do offer the potential to revolutionize the economy through productivity improvements.

The question is will there be a price where Nvidia, Microsoft, and the other major players are too high?

There’s also the risk that AI doesn’t turn out to be as productive as people think.

ChatGPT and Gemini are great for what they do, but we haven’t seen robots stocking shelves or drones delivering our goods (at least on a massive scale). Those are the types of things that skyrocket productivity. Are these things even possible in my lifetime?

AI is also very expensive from a spending and resource point of view. AI datacenters require vast amounts of electricity and water to function. Tech companies are spending billions of dollars each year, but what happens if all that spending doesn’t turn into a profit soon enough? Eventually investors are going to want to see something revolutionary.

What if China introduces an AI that is cheaper and just as powerful as an American AI? What would that do to the valuations of the major tech companies?

There’s no doubt AI is the future, but no one knows the road that will be traveled to get there.

Liquidity & Debt Monetization: Profiting From Money Printing

Liquidity and Debt Monetization companies directly benefit from increases in the M2 Money Supply and the US government issuing new debt.

The US government will have to issue more debt to cover all its spending. The US hasn’t had a balanced budget since 2001. 

I don’t see US politicians making the hard decisions to balance the budget in the future, so more debt is the only way to keep the system functioning.

We know that the M2 Money Supply CAGR is 6.63% per year since the ending of the gold standard.

The national debt continues to increase each year as well.

Liquidity and Debt Monetization companies benefit directly from both of these increases.

Liquidity Monetization: Transaction Royalties and Trading Volume

Companies in Liquidity Monetization profit from the movement of money. They don’t care if prices go up or down, as long as money is exchanging hands. This is called the velocity of money.

The Toll Roads: Transaction Royalties

These companies get paid every time you spend. They include:

• Visa (V)
• Mastercard (MA)
• American Express (AXP)

Because we are living in a K-shaped economy, it will be interesting to see how American Express performs compared to Visa and Mastercard. I suspect that AXP will outperform because the rich can afford to continue spending.

The Volatility Engines: Trading Volume

The Volatility Engines benefit from trading volume. They profit during times of greed and panic.

• CME Group (CME)
• CBOE Global (CBOE)
• Intercontinental Exchange (ICE)
• Nasdaq (NDAQ)
• Goldman Sachs (GS)
• Interactive Brokers (IBKR)
• Robinhood (HOOD)
• Coinbase (COIN)

Debt Monetization: Private Credit and Asset Management

These companies profit from the accumulation of debt and wealth. They don’t need money to move like Liquidity Monetization companies. They just need the pile of money to get bigger.

Debt Factories: Private Credit and Lending

When the government issues debt and prints money, these companies manufacture the yield.

• Blackstone (BX)
• KKR & Co (KKR)
• Apollo (APO)
• Blue Owl (OWL)
• Ares Management (ARES)

Private credit and lending is risky. For example, if you buy Apple stock, you can check the price of it at any time and decide how you think it’s priced. Is it overvalued, undervalued, or priced just right?

Blackstone owns private companies and buildings and prices them. You and I have no idea if they are priced fairly. Blackstone might say that a private company they own is worth $1 billion, when in reality it might be worth less. There’s no way for the average person to fairly judge the true value of Debt Factorie’s assets.

Inflation Beneficiaries: Asset Aggregators

These companies collect fees based on their Assets Under Management (AUM). If more money flows into the system, their revenues rise automatically.

• BlackRock (BLK)
• State Street (STT)
• Charles Schwab (SCHW)
• Morgan Stanley (MS)

The Gatekeepers: The System Tolls

You can’t issue debt or create new ETFs without paying these companies.

• S&P Global (SPGI)
• MSCI Inc. (MSCI)
• Moody’s (MCO)

Government Spending: Defense, Healthcare, and Industrial Policy

The third major category of investments in a high debt to GDP world is Government Spending.

It’s pretty self explanatory. 

Companies in this category benefit from the government spending money. The US government spends about $6.5 trillion a year, making it the largest customer in the global economy.

These companies have revenue streams that are aligned to the federal budget. They get paid no matter how the economy is doing.

Government spending will continue to increase because it simply has to. Inflation is a feature of the financial system, so prices will keep increasing.

Government spending can be broken down into three different categories: Entitlements, War Machine, and Industrial Policy.

Entitlements: Healthcare and Pharma

This is currently the largest and most non-discretionary chunk of the US budget. As Baby Boomers age, the government is forced to pay for their care. These companies benefit from mandatory healthcare spending. They include insurance companies and pharmaceuticals.

• UnitedHealth (UNH)
• Eli Lilly (LLY)
• Merck (MRK)
• AbbVie (ABBV)
• Amgen (AMGN)
• Johnson & Johnson (JNJ)
• Gilead (GILD)
• Pfizer (PFE)

The War Machine: Defense & Intelligence

War is inflationary.

Just in the last five years the United States has been involved in conflicts in Afghanistan, Israel and Iran, Yemen, Ukraine and Russia, and Venezuela. These conflicts all cost money.

It’s important to remember that the United States is a global superpower. It’s going to do everything that it can to remain the top country in the world. It will spend as much money as it needs to in order to protect its own interests.

Companies involved in defense and intelligence will continue to benefit because of this. 

Some of these companies include:

• Lockheed Martin (LMT)
• Raytheon (RTX)
• General Dynamics (GD)
• GE Aerospace (GE)
• Palantir (PLTR)

Industrial Policy: Infrastructure & Energy

This category relies more on politics than the other two. It depends on if the political party in charge wants to print money to “reshore” manufacturing and/or improve national infrastructure

Personally, manufacturing won’t come back to America. It will be too costly for companies to move their plants and warehouses from overseas back into the US. Not to mention paying American citizens good wages and benefits. It’s cheaper for them to offshore everything.

There also has to be a lot of political will to improve national infrastructure. The federal government could allocate money to states and local communities, but there’s always issues with bureaucracy. 

Industrial Policy isn’t a sure thing like Medicare, Medicaid, and defense spending.

That being said, here are some potential companies that could benefit from Industrial Policy:

• GE Vernova (GEV)
• NextEra Energy (NEE)
• Constellation (CEG)
• Caterpillar (CAT)

Future Government Spending: AI, National Security, and Climate Change

Looking 30 years into the future, are there any other sectors the US government might get involved in?

The most obvious one is AI.

The US government seems to be in an arms race with China when it comes to AI.  I think both countries are racing to develop artificial general intelligence (AGI) as fast as they can. AGI is the endgame in the AI race. Whoever can create AGI first wins.

Because of that, there’s no way the United States is going to let China win. It will do everything in its power to prevent that from happening. 

The US government could get even more involved in semiconductors, data centers, and anything else related to AI because it will be for “national security”.

Another area where the government might have to spend more is related to climate change. 

We’ve already seen massive fires destroying entire neighborhoods, insurance companies leaving states because it’s not profitable anymore, and other climate related disasters that are costly.

Climate change is highly political. The government won’t do anything proactive to prevent or mitigate the risks from climate change, but they might be forced to act as the years go on.

The Real Economy: Consumer Staples and Consumer Discretionary

The Real Economy includes companies that are in the consumer discretionary and consumer staples sectors.

Their profits rely on people spending money in their stores or online. However, these companies also have to purchase or create their goods to sell, which will become more expensive over time. Because of that, they will have to pass those costs onto the consumer and it will depend on economic conditions if people are willing to spend their money. 

For example, if people don’t have disposable income because groceries are too expensive, then they might put off that home improvement project until they can afford it.

I categorized Real Economy companies into three groups: Essentials, Hybrids, and Non-Essentials.

Essentials: What We Need to Live

These companies sell products that we all need in order to live. These are groceries, certain consumer staples, insurance, and utilities.

People are less likely to cut spending in these companies because they’re needed for daily living.

Some examples are:

• Walmart (WMT)
• Costco (COST)
• Waste Management (WM)
• Progressive (PGR)
• T-Mobile (TMUS)

Hybrids

The next category of Real Economy companies are hybrids. Hybrids do well when the economy is strong because people have extra money, but when the economy is poor sometimes you still have to spend money at these companies. They might also do well because people are willing to spend to repair older things instead of buying new.

These companies include:

• O’Reilly Auto Parts (ORLY)
• Home Depot (HD)
• TJ Maxx (TJX)

Non-Essentials: The Nice to Haves

These are the typical consumer discretionary companies. When money is tight at home, these are the first things cut from the budget.

• Starbucks (SBUX)
• Netflix (NFLX)
• Disney (DIS)
• McDonalds (MCD)

It’s hard to get really excited about any company in the Real Economy. There might be some big new exciting product that comes out that everyone loves, but even then those types of things tend to be short lived. 

Companies that offer the essentials like Walmart and Costco will probably continue to do well because they offer memberships and groceries.

Non health insurance companies and utilities will continue raising prices, which will continue raising their profits.

Consumer discretionary companies that cater exclusively to high end consumers might do better than expected. The rich keep getting richer, so they will continue spending at luxury stores.

I view Real Economy stocks as a defensive play. These companies will do well nominally, but won’t deliver real wealth in the long run. 

Real/Scarce Assets: Gold, Bitcoin, and Commodities

The last category of investments in a high debt to GDP world are real assets.

When the M2 Money Supply and debt increase, the price of finite things also increases.

I admit, this is the category I am least knowledgeable about, but I am excited to learn more because I think these companies will do well in the future.

There’s a few different categories to keep an eye on.

Strategic Metals: Electrification and AI

The AI arms race will require more and more metals to power it. This benefits companies that work in copper, gold, uranium and other rare earth metals.

Companies and ETFs include:

• Southern Copper (SCCO)
• REMX
• XME

Energy Reserves: Liquid Gold

Oil is the lifeblood of all economies. It’s required for almost everything. There’s a lot of geopolitical risk with oil companies, but there’s no doubt they are important to keep the global economy functioning.

• Exxon Mobile (XOM)
• Chevron (CVX)
• XLE

Productive Land: Real Estate & Digital Dirt

Real estate is a popular investment, but in a fiscal dominant world, you want your land to be doing something productive. 

• Prologis (PLD)
• Equinix (EQIX)
• Welltower (WELL)

Monetary Scarcity: Stores of Wealth

These aren’t necessarily companies, but assets that opt out of the financial system altogether. Their value can’t be diluted from more money printing.

• Gold (GLD)
• Bitcoin (IBIT)

Final Thoughts: A Portfolio for the Future

The United States is in so much debt, the previous ways of thinking about investing will become obsolete.

The US can’t afford to pay the interest on their debt without borrowing. More debt is being issued to pay current debt.

The Federal Reserve can no longer accomplish its dual mandate of maximum unemployment AND keeping inflation at two percent. They are limited by the national debt as well. 

If inflation continues to rise, they won’t be able to raise interest rates because it will increase the interest payments on the national debt requiring even more borrowing.

I think the Federal Reserve will continue to cut rates as low as they can. The US will try to grow its way out of debt.

The M2 Money Supply will increase, debt will increase, and the dollar will continue losing its purchasing power. 

With all that being said, there’s a way to take advantage of this. 

By viewing investments through a fiscal dominance lens, we can find the right sectors, companies, commodities and assets to obtain real wealth.

I created five categories to help understand how to view investing in a fiscal dominance future.

They are: Productivity Premium, Liquidity & Debt Monetization, Government Spending, The Real Economy, and Real/Scarce Assets.